Saturday, August 29, 2015

Where in the ABCT are Stock Market Bubbles supposed to be the Mechanism by which Capitalist Economies are destabilised?

It is a crucial point: Austrians complain about asset bubbles, but their Austrian business cycle theory (ABCT) or economic theory in general does not focus on stock market speculation or asset bubbles as a fundamental and inherent means by which an economy is destabilised.

For example, in the ABCT it is real and unsustainable higher-order capital investment that is supposed to wreck the economy, not debt-financed asset speculation.

The Austrians today are falsely claiming that they have some kind of prescient theory explaining the recent stock market gyrations or asset bubbles. This is rubbish.

Karen I. Vaughn in her excellent book Austrian Economics in America: The Migration of a Tradition hits the nail on the head:
“Mises never discusses the possibility of systematic speculative error except in the context of his trade cycle theory, in which speculators-investors are misled by improper monetary signals emanating from a fractional reserve banking. Yet if the future cannot be predicted, or as Shackle would say, if the future is created out of the actions of the past, why is it not least conceivably possible for speculative activity to be on net incorrect at least some of the time? Certainly, we have the empirical evidence of speculative bubbles that are endogenous to markets as an example of market instability. One would think that the extent and potential limiting factors that affect such endogenous instabilities would be of great importance for fully understanding market orders, yet it is an issue surprisingly missing in the Austrian literature. Hence, although, we can appreciate the force of Mises’ argument as far as it goes, it seems that a crucial part of the case for the effective functioning of a market economy is missing.” (Vaughn. 1994: 87–88).
Vaughn is entirely correct: the Austrians’ trade cycle theory is flawed by failing to take into account asset bubbles in a systemic theoretical way.

When we add to this the failure to understand and apply to economic theory the concepts of fundamental uncertainty, subjective expectations, debt deflation, and wage and price rigidities, as well as their commitment to bankrupt ideas like loanable funds theory, we have one deeply defective and unsound theory.

BIBLIOGRAPHY
Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.

10 comments:

  1. Correct me I'm wrong, but I think Austrians lack a proper understanding of endogenous money supply. Their interest rate theory implicitly implies 100% reserve banking, and all "excessive" money supply, leading to misleading prices and capital misallocations, coming exclusively from an external actor : the state, through the central bank.
    Moreover, their microeconomics are mostly sound but their theory mises "composition effects" (in the sociological sense as defined by Raymond Boudon) that makes macro effects different from the sum of all underlying micro-level actions - this is understandable as proper analysis of reflexivity and social phenomena only came after Mises and Co devised the ABCT.
    In the end, their theory cannot grasp endogenous instability in markets since it doesn't conceive macro effects per se, only micro.

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    1. "composition effects"
      Yes. They are wedded to a foolish form of reductionism which they call "methodological individualism." Now I am a complete, hard-core reductionist ( "of the worst kind" according to two published Austrian authors). So I agree that "there is no society" apart from the individuals in it (just as there is no cell apart from the molecules in it) but I disagree with their conclusion that reasoning about individuals can ignore social effects. As you put it, sums instead of interactions and constraints.

      Oddly enough, many of these folks, like Murphy, utterly *deny* reductionism at the level of the individual, and apply this foolish "axiom of action" as if human beings were monads.

      This problem with reductionism from both above and below is why I like to say Bob Murphy's real problem is that *he doesn't understand what a human being is*.

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  2. If "Austrians" (more correctly: "Misesians") had a coherent theory, then it would have the problem you cite (the lack of macro effects). But they don't have a coherent theory. They've a mixture of slogans that they use to rally people with. Frankly, it's very much like marxian economics. The primary goal of marxian economics is to provide politically effective slogans for socialism. The primary goal of "misesian" economics is to provide politically effective slogans against socialism. Why they don't understand endogenous money? Because it's politically expedient to tell the masses that they're poor because bankers have cheated on them.

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    1. I think you underestimate the extent to which they have drunk the Kool-Aid. The whole Mises-Rothbard thing is built on an appeal to aesthetics and elegance. "What if all rights are property rights?" and "What if we can deduce all property rights from introspection?" This appeals to the inner mathematician, to the sense of elegance such a theory can provide. It has beauty.
      AS Gibbon put it, "the only defect of these pleasing compositions is the want of truth and common- sense."

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    2. I agree that there is an appeal to elegance. But in this case elegance is not in the logical coherency (this is really laughable!), but in the apparent simplicity, *perceived* widespread acceptance by people who claim to study economics and some empirical successes.

      Beside, often people manage to convince themselves of what is in their self interest anyway. Like every religions, it's a mixture of believing and having an incentive to believe.

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  3. This whole "lengthening the production chain" idea is interesting. It certainly happens sometimes; we build things, we build tools to build them better, we build tools to buid the tools, etc. If the theory were right though, wouldn't we see abandoned factories that make tools to make tools to make tools to make tools to make fence-posts?

    One area where we *do* see this sort of "lengthening" is in software. Tools to make frameworks to make tools to ... etc. But We don't see relentless lengthening of the chain, we see periodic replacement and collapse. Usually because an idea proves too complex, or technology changes, or a new idea appears. I have not been tracking it but I haven't noticed that this sort of thing causes or is tied to software development busts.

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    1. It's interesting but 1) production is not necessarily a chain but could be a loop and most importantly 2) interest rates DO NOT DIRECTLY DETERMINE THE OPTIMAL LENGTH OF SUCH CHAINS.

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  4. "One might note the superficial similarities between what we have just described and the boom-bust cycle of the Austrian Business Cycle Theory (ABCT). The key difference, however, is that the ABCT assumes that only central
    bank action can affect the money rate on interest. As we have seen, however, unless we assume perfect foresight on the part of savers/investors there is no logical reason to assume that they will set the money rate of interest in line with the natural rate. It would be interesting to consider how Austrian theorists, who generally recognize Knightian
    uncertainty as being operative in capital markets, would respond on this point. The only viable response to this so far as we can see is to advocate some form of the EMH and rational agents, but if Austrians were to do so it would no longer be clear what would distinguish them from, for example, New Classicals."

    http://www.levyinstitute.org/pubs/wp_817.pdf

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    1. ABCT is not a coherent theory that assumes something and derives something else. It's just whining vaguely about "bankers" and politicians.

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    2. And often whining with ulterior motives too. See my previous post: http://socialdemocracy21stcentury.blogspot.com/2015/08/where-in-abct-are-stock-market-bubbles.html?showComment=1440946695812#c572454071164779628

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